Question

The Warren Company is emerging from bankruptcy r eorganization. Its reorganization value is 3 million while allowed claims plus debts incurred during bankruptcy are 4 million. The previous owners continue to hold 42% of the company's capital stock as it emerges from bankruptcy. Which of the following is true?

a. Fresh start accounting is not allowed because the previous owners still hold 42% of the outstanding stock
b. Fresh start accounting is required because the reorganization value is less than the allowed claims plus the debts incurred since reorganization
c. Fresh start accounting is required because the reorganization value is below the debt amount and the previous owners end up with less than 50% of the voting stock
d. fresh start accounting is not allowed because the company has reorganization value of 4 milion

Answer 1

Fresh start accounting is required for the Warren Company because its reorganization value is less than the allowed claims and debts incurred during bankruptcy, and the previous owners hold less than 50% of the voting stock post-bankruptcy. The correct answer is option c.

Step-by-step explanation:

The question pertains to the application of fresh start accounting for the Warren Company as it emerges from bankruptcy reorganization. Fresh start accounting is relevant when certain criteria are met post-bankruptcy. It allows a company to reset its financial statements as if it were a new entity, without the baggage of past financial issues.

The correct answer to the question is that fresh start accounting is required because the reorganization value is below the debt amount and the previous owners end up with less than 50% of the voting stock. According to accounting standards, if the reorganized company's new common stock (plus any new in-the-money share options) held by the previous owners is less than 50% of the voting shares of the emerging entity, and if the reorganization value is less than post-petition liabilities and allowed claims, then fresh start accounting is typically required.

In this scenario, since the reorganization value is 3 million, which is less than the allowed claims and the debts incurred during bankruptcy totaling 4 million, and the previous owners are left with less than 50% of the voting stock, fresh start accounting would indeed be applied.